How to Boost Growth While Reducing the Deficit

Noam Scheiber’s article on the Obama administration’s dilemma as it tries to pair the dual imperatives of job-creation with deficit control is pretty disturbing. In particular, it suggests an administration that’s started to internalize some of the political constraints on fiscal expansion. To review, back last year Christina Romer told her colleagues that something like $1.2 trillion in fiscal stimulus was needed. For political reasons, that was scaled down to something more like $800 billion. The Senate then scaled that back to something more like $700 billion. So the day Barack Obama signed ARRA, his administration’s analysis suggested that $500 billion in additional stimulus would be a good idea. Then it turned out that the winter of 2009-2010—which basically all happened before the stimulus went into effect—featured a much sharper contraction than had been expected.
So it’s very strange to learn that members of the Obama administration economic team have started to feel that the deficit is too big, when their analysis strongly suggests that it’s much too small. They say they’re worried about the bond market, but the nice thing about the bond market is you can just go look it up and there’s no problem there:
Whatever reason you might have for worrying more about the deficit than you did three years ago, it can’t be the bond market. The bond market is telling you to worry less.
All that said, there is a way to create jobs and reduce the deficit. It’s to persuade the Federal Reserve Open Market Committee to implement the Gagnon Plan for additional quantitative easing. In an ideal world, the European Central Bank, the Bank of Japan, and the Bank of England could also be persuaded to follow Gagnon’s outline. His proposal to have the Fed buy $2 trillion in government bonds, with an average maturity of 7 years, would increase the GDP growth rate. That would make tax revenues higher. It would also increase the level of employment, reducing the need for outlays on unemployment insurance, Medicaid, SNAP, etc. That reduces the deficit.
If monetary easing has such magic properties, why don’t we do it all the time? We don’t do it all the time because we often worry about inflation. But right now inflation is extremely low and core inflation is expected to decline. If inflation were higher than it is right now, we’d be hitting our inflation target. That’s doesn’t sound so bad. If inflation were a bit higher than that, we’d be returning to the long-run price level trend. That doesn’t sound so bad either. And we’d have a more prosperous country, with fewer jobless people and a lower budget deficit. That nobody outside the blogosphere is even talking about this possibility is extremely frustrating.

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WASHINGTON — Federal Reserve Chairman Ben Bernanke strongly defended the U.S. central bank’s bond-buying stimulus before Congress on Tuesday, saying its benefits clearly exceed possible costs.
The Fed chairman also urged lawmakers to avoid sharp spending cuts set to go into effect on Friday, which he warned could combine with earlier tax increases to create a “significant headwind” for the economic recovery.

The policy of world’s largest economies of quantitative easing that is purposed to stimulate the fragile market has now started raising questions and concerns over whether it will actually prove successful over the long-term.

Japan has been an experiment in economics ever since its crushing defeat at the end of World War II. First, Tokyo employed inventive techniques to rebuild its economy and wealth – the export-led, state-directed system in which bureaucrats “targeted” industries for special support – that broke with economic tradition and became a development model for the rest of the region to follow. Then after the country’s massive stock-and-property-price bubble exploded in the early 1990s, Japan became a much-examined case study in how to handle (or not handle) a financial crisis.

Japan has been an experiment in economics ever since its crushing defeat at the end of World War II. First, Tokyo employed inventive techniques to rebuild its economy and wealth – the export-led, state-directed system in which bureaucrats “targeted” industries for special support – that broke with economic tradition and became a development model for the rest of the region to follow. Then after the country’s massive stock-and-property-price bubble exploded in the early 1990s, Japan became a much-examined case study in how to handle (or not handle) a financial crisis.

When Ben Bernanke asserted last month that the Federal Reserve doesn’t ever have to sell assets, he raised questions about how the central bank can withdraw its record monetary stimulus without stoking inflation.

When Ben Bernanke asserted last month that the Federal Reserve doesn’t ever have to sell assets, he raised questions about how the central bank can withdraw its record monetary stimulus without stoking inflation.

What effect did the Federal Reserve's quantitative easing programs have on U.S. stock prices in the three years from November 2008, when it was first suggested, and today?
To find out, we'll do an event analysis - we'll match up the level of stock prices as measured by the S&P 500 with the timing of the Federal Reserve's announcements and implementation of its two rounds of quantitative easing (aka "QE1" and "QE2").

The report below comes courtesy of Nouriel Roubini’s team of analysts at RGE.The chef on the Titanic is said to have survived the icy waters by thinning his blood with booze as the band played on. China’s approach to the global financial crisis followed a similar strategy.